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ABCs of investing in Australia's resource base: What China can learn from Japan

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SYDNEY, Australia: Wei Zhang, chancellor to China's seventh-century Emperor Tang Taizong, reputedly told his master to "use history as a mirror." China's modern-day minerals mandarins could benefit from this advice as they look to secure supplies through investments in Australia and elsewhere.

China has long favored Australia's resource sector, never more so than last year when cash-strapped Aussie miners sought Chinese funds to stay afloat. But while the economic benefits to both parties seem undeniable, the execution has been largely unsuccessful, with two high-profile cases demonstrating the uneasy path Chinese investment faces Down Under.

Australia, one of the world's top exporters of iron ore and other commodities, has ridden out the economic downturn better than most, thanks in part to its proximity to China. But the financial crisis and steep drop in commodity prices in late 2008 and early 2009 had a major impact on miners.

"For the first part of the year companies would have to sell their souls to get financing, and banks were calling in loans because a lot were expiring in 2009," said Thomas Booth, commodities trader with Novus Capital in Sydney, Australia.

"Some companies were called to repay the debt even if they were able to service it," Peter Arden, senior research analyst at ORD Minnett, said.

The poster child for Australia's unforgiving credit environment last year was copper-zinc miner OZ Minerals Ltd. The company was a few months away from production at its Prominent Hill copper-gold mine in Western Australia when trading in its stock was suspended because the company couldn't roll over its debt.

OZ Minerals grasped for an international lifeline, which came in the form of an Australian $2.6-billion ($2.4-billion) all-cash buyout offer from China Minmetals Corp., one of China's biggest metal trading houses. The deal valued OZ at A82.5 cents (75.1 cents) a share—a 50-percent premium to its last traded price.

But Australian Treasurer Wayne Swan blocked the deal, saying the sale of Prominent Hill posed a security risk because the mine was too close to the Woomera weapons-testing range, a key Australian defense asset. The Australian resource community largely mocked Swan's "defense asset" explanation, but the rebuff proved that, despite dire market conditions, Chinese direct investments still face an unpredictable regulatory approval process.

Undeterred, Minmetals quickly returned with a successful offer of nearly $1.39 billion for all OZ Minerals' assets excluding Prominent Hill, indicating—as have a raft of other overseas investments in recent years—that China is serious about securing raw material supplies.

China's hunger for commodities stems from the country's impoverished geology, and it has made minerals security a top priority. The Asian powerhouse is pursuing this goal with a three-pronged approach: domestic exploration; strategic stockpiling; and investments in foreign projects and companies. But the success of domestic exploration is limited by geology, and storing bulk dry goods can be uneconomic, especially in the case of iron ore, according to Citigroup global commodity analyst Alan Heap. That leaves investment as the best possible strategy, and China has aggressively bid for mining assets in Australia and Africa, where it recently displaced the World Bank as the biggest grantor.

African investments require aid and infrastructure expenditures, however, and come parceled with security and political risks. Similar Australian ventures do not share such burdens. Moreover, Australia's proximity to China makes for reduced transportation costs.

The relationship between the two countries is symbiotic, as the Australian resource sector would stall without Chinese funds and China's voracious appetite for commodities. Even so, China's bulldozer attempts to scoop up entire companies or major assets were met with distrust and disdain by the Australian resource community.

China's second troubled Australian investment in recent years was the attempt by state-owned Aluminum Corp. of China (Chinalco) to buy into Rio Tinto. Chinalco's $19.5-billion bid for Rio, which had $10 billion of a $40-billion loan due in early 2009, included the purchase of convertible bonds for $9.2 billion, which could have yielded Chinalco an 18-percent equity stake in the Anglo-Australian miner. More alarming was the $12.3 billion earmarked to turn some of Rio's iron ore, copper and aluminum assets into joint ventures. The deal would have handed government-held Chinalco direct stakes in some of Rio's prime assets. But market conditions improved and Rio scrapped the deal.

China is not the first resource-poor nation seeking to secure mineral supplies from Australia. Japanese commodity trading houses embarked on a similar path in the 1970s, with Mitsubishi Corp., Mitsui Group and Marubeni Corp. buying equity stakes in foreign miners to help develop new projects. But the Japanese employed a deft touch—the typical deal involved a small equity stake of 5 to 10 percent, a board seat, and often an off-take agreement that ensured mineral supplies. The strategy rewarded Japan with relative minerals security, and today the trading houses cumulatively hold around 4 percent of world copper supply, or 49 percent of the country's copper demand, according to Citigroup.

Since China looks forward to decades of resource-driven economic growth, it stands to improve its chances of accumulating stakes in Australian miners by mirroring Japan's subtle tactics. TATYANA SHUMSKY

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